A “strategic acceleration from a position of strength” sounds a lot better than a “humiliating retreat after more than a decade of strategic failure”. But the carefully chosen wording of UBS’s announcement about the radical restructuring of its investment bank can’t hide the fact that the Swiss bank – and many of its rivals – has been in denial for years.

By closing down most of its sub-scale fixed-income division, shifting three quarters of its risk-weighted assets into a non-core unit that will be wound down over three years, and firing around one third of the staff in the investment bank, UBS has finally accepted that it cannot compete at the top table of an industry whose economics have been shot by a sustained downturn in activity and regulatory reform.

It is not the first bank to take radical action. In the past year, Credit Suisse has cut the risk-weighted assets in its investment bank by more than UBS plans to do, and both Deutsche Bank and Royal Bank of Scotland are cutting the risk in their businesses by similar amounts. But the unusually public admission of defeat by UBS marks the first time a big investment bank has accepted that it cannot make the grade and that it needs to pull out of huge swathes of the business rather than tinker around the edges.

But it also highlights the extent to which banks have been allowed to get away with failure in such plain sight for so long. It’s not as if the problems at UBS are a surprise. As an investment bank, UBS doesn’t work very well and hasn’t done so for some time. It lost more than Sfr50bn during the financial crisis and has lost money in five of the past six years.

It has not been helped by the fact that over the past decade it has worked its way through eight investment bank chief executives (or combinations of chief executives). Each of them – from the hard-nosed John Costas and the affable but out of his depth Huw Jenkins, to Carsten Kengeter – has tried to trade his way out trouble by building the sort of fixed-income business that a PowerPoint strategy presentation suggested was needed in order to qualify as a top-tier investment bank. Apparently having a first rate equities and investment banking business and world class wealth management business wasn’t enough.

But this masochistic attraction to fixed income has instead proved to be the bank’s downfall. In the past four quarters, the investment bank at UBS made a pre-tax loss of Sfr2.2bn. Even if you strip out a Sfr3bn impairment charge from the restructuring, it has an underlying cost/income ratio of 90% and a pre-tax return on equity of 4%. As someone quipped last week, UBS has grown tired of losing money in fixed income; it’s now going to focus on losing money in equities and investment banking instead.

Hope over experience

But it’s almost unfair to pick on UBS when there are so many other banks in denial. For all of the concerns about the cold winds blowing through the industry, not much has changed. The thousands of job cuts across the industry may be brutal for the individuals concerned but they don’t begin to go far enough. Far from shrinking, balance sheets at investment banks have grown bigger over the past three years.

Instead of taking tough decisions, most investment banks have engaged in an elaborate game of chicken, hoping that enough of their rivals will blink first and that the markets will recover to transform bloody-mindedness into strategic genius.

So, which banks still operate businesses they probably should not? Where to start?

You could, for example, ask why Nomura has any investment banking or sales and trading outside of Japan that isn’t solely designed to service its Japanese clients. Why Morgan Stanley persists in trying to build a fixed-income business when it might better focus – like UBS – on its first-class equities and investment banking business. Why Barclays continues to insist that its equities and advisory business in Europe and Asia is in some way critical to its overall future. Why Societe Generale or BNP Paribas still have outposts in the US and Asia, or why the likes of RBS, Lloyds Banking Group, or Credit Agricole have any investment banking capacity at all.

The official term for this dithering is “retaining optionality”. This is a clever-sounding expression for keeping your options open because you don’t want to look stupid closing down a business just before it comes roaring back, as happened to Merrill Lynch after the dotcom crash and most of the industry in 2009. The big problem with this “optionality” is that it does not come cheap: as with any out-of-the money option, it can be expensive to service.

Collective delusion

There are lots of reasons why banks have been able to get away with paying through the nose on underwater options for so long. Most obviously, for many years no one really knew the options were out of the money because, like many things in the decade before the financial crisis, they were mispriced. Cheap money, mispriced risk and unconstrained leverage can make almost any bank look like Goldman Sachs.

This in turn fuelled a sense of institutional and individual invincibility, in which management was more incentivised to build businesses than to make them profitable. At the same time, senior figures in the industry, who tend not to lack in self-confidence or persuasion, perhaps came to believe their own hype: with their help it should be a cinch to turn a hypothetical second-tier Dutch savings bank into a powerhouse in global fixed income.

Today, many of the most senior executives in the industry who have the power to take the radical decisions required – such as Brady Dougan at Credit Suisse or Anshu Jain at Deutsche Bank – might find it harder to do so because they are so heavily invested in having built up and run the investment banking business in the first place. Note that it was only when two outsiders took over at UBS – chief executive Sergio Ermotti and chairman Axel Weber – that the bank was able to make a dispassionate decision.

Too many investment banks still seem to be run based on the hope that the good times will return; on the wrong metrics, such as market share or scale; or on seductive strategies based on big assumptions and bigger egos instead of on hard evidence.

If nothing else, the decision by UBS to admit defeat should send a strong signal through the industry that it is time for banks to take a long hard look at their business, bite the bullet and wield the axe.

--William Wright is a columnist on investment banking. Contact him on william@william-wright.com and follow him on Twitter at www.twitter.com/williamw1

--This article was first published in Financial News's print edition on Monday, November 5, 2012